The Belgian Connection

One of the biggest questions at the end of 2013 was how the Treasury market
would react to the reduction of bond buying that would result from the Federal
Reserve's tapering campaign. If the Fed were to hold course to its stated intentions,
its $45 billion monthly purchases of Treasury bonds would be completely wound
down by the fourth quarter of 2014. Given that those purchases represented
a very large portion of Treasury bond issuance at that time, it was widely
assumed by many, me in particular, that the sidelining of such huge demand
would push down the price of Treasury bonds. Without the Fed's bid, interest
rates would have to rise.

But almost five months later, yields on the 10-year Treasury bond are 50 basis
points lower than they were at the end of 2013, despite the fact that the Fed
has officially trimmed its monthly purchases in half. Apparently, plenty of
other buyers were prepared to fill the void. Many have concluded that Uncle
Sam doesn't need the Fed after all. But a close look at international activity
in the Treasury market reveals some odd patterns that should be explained.

Over the last six months Belgium has started to behave eccentrically, even
by Belgian standards. No, the small country of 11 million has not decided to
stop making chocolate or waffles. It has decided to increase its buying of
U.S. Treasury bonds...in a very big way. According to latest U.S. Treasury
Department data, since August of 2013 entities in Belgium have purchased and
held a stunning $215 billion of U.S. Treasuries. This figure is equivalent
to about half the country's annual GDP, and equates to almost $20,000 for every
living Belgian. Prior to that time, Belgium had held its cache fairly steady
at around $170-$190 billion. But by March, that total had increased by almost
130% (to $381 billion) in just seven months. The purchases represented 61%
of the total increase in foreign holdings of U.S. Treasuries over that time
frame. Given the fact that Belgium, as of last September, had less than 3%
of the Treasury bonds held by foreign sources, this is strange behavior indeed.

Of course exactly who is buying those bonds remains a mystery. It's only known
for sure that a Belgium-based clearing house called Euroclear is "likely responsible" for
holding the $200 plus billion in Treasuries. It's amazing in this day and age
when every e-mail and phone call is scrubbed for security content that hundreds
of billions of dollars could move across borders without anyone really knowing
what is going on. Of course this is likely only possible if official sources
themselves are the transacting parties.

What is clear is that this is not likely the government of Belgium, or private
Belgian capital, that is doing the buying. The numbers are just too large.
This is particularly true in the First Quarter of 2014 when the buying averaged
a stunning $41.5 billion per month (January was the biggest month with $54
billion). In all likelihood, the only European buyer with a wallet that big
would be the European Central Bank (ECB) itself. But why would the ECB buy
when the Federal Reserve was supposed to be tapering?

It is widely recognized that as the flow of capital increases exponentially
across borders, and financial systems become more globally integrated, international
central bank cooperation has increased. This is especially true between the
Federal Reserve and the European Central Bank (ECB) which have closely coordinated
policy to deal with the Great Recession of 2008 and the European Sovereign
Debt Crisis of 2011. Exactly how, where, and why these banks have worked together
is a little harder to imagine.

Back in late 2011, when the sovereign debt crisis of Greece, Spain, Italy
and Portugal threatened to fracture the European Union and take down the euro
currency, the Wall Street Journal reported the Federal Reserve was engaging
at that time in a "covert bailout" of European banks. Using what was known
as a "temporary U.S. dollar liquidity swap arrangement," the Fed provided billions
in funds that its European counterpart used to bail out its banks. The Journal speculated
that the roundabout arrangement was followed in order to get around legal restrictions
that prevented the ECB from lending to banks directly. The Journal called
the arrangement "Byzantine" and questioned whether its design was simply meant
to confuse the press and investors as to who was funding whom. In any event,
the program seems to have achieved its end of keeping European banks solvent
until the debt crisis had abated.

The Belgian head-scratcher may therefore be a simple case of central bank quid
pro quo. In fact, on my radio program today, former Congressman Ron Paul
shared my suspicions that there was indeed some type of "quid pro quo" coordination.
While there is no smoking gun, the timing and scope of the buying is certainly
suggestive of a coordinated effort. Confidence that the financial markets
would stay stable during the tapering campaign was a critical element of
the program's success. Any panic in the bond market would cause yields to
spike, which would have a strong negative effect on stock prices and economic
confidence. If the fear persisted for more than a few weeks, the Fed would
have been forced to an embarrassingly early backtrack. The lost credibility
would have greatly limited the Fed's latitude for further maneuver.

But what if the ECB started buying just as the Fed stopped? Better yet, what
if the ECB purchases were larger than the taper? It would then appear that
the Fed buying was simply a footnote in the current environment of ultra-low
interest rates, not the driving force. It may not be coincidental that the
Belgian buying began in earnest just as the tapering got underway. Something
may in fact be rotten, and it's not in Denmark...but several hundred kilometers
to the southwest.

Rather than looking to explain the unusual spike in Belgian coffers, most
market watchers are fixated by recent comments by Mario Draghi that the ECB
is poised to launch a quantitative easing-style bond buying campaign in order
to weaken the euro and to push up inflation in Europe. If that is the case,
how long could the ECB be expected to fight a two-front monetary war...carrying
water for the Fed while buying European bonds simultaneously? We must expect
that any clandestine campaign by the Europeans to support Treasuries will have
a brief shelf life, which could get even briefer if the ECB initiates their
own QE.

It is a testament to the bovine nature of our financial media that this story
is not being pursued strongly by all the power the fifth estate can muster.
But who cares when rates are low and stock prices high? Have another chocolate.
The Belgian ones are the best.

Mr. Schiff is one of the few non-biased investment advisors
(not committed solely to the short side of the market) to have correctly called
the current bear market before it began and to have positioned his clients
accordingly. As a result of his accurate forecasts on the U.S. stock market,
commodities, gold and the dollar, he is becoming increasingly more renowned.
He has been quoted in many of the nations leading newspapers, including The
Wall Street Journal, Barron's, Investor's Business Daily, The Financial Times,
The New York Times, The Los Angeles Times, The Washington Post, The Chicago
Tribune, The Dallas Morning News, The Miami Herald, The San Francisco Chronicle,
The Atlanta Journal-Constitution, The Arizona Republic, The Philadelphia Inquirer,
and the Christian Science Monitor, and has appeared on CNBC, CNNfn., and
Bloomberg. In addition, his views are frequently quoted locally in the Orange
County Register.

Mr. Schiff began his investment career as a financial consultant
with Shearson Lehman Brothers, after having earned a degree in finance and
accounting from U.C. Berkley in 1987. A financial professional for seventeen
years he joined Euro Pacific in 1996 and has served as its President since
January 2000. An expert on money, economic theory, and international investing,
he is a highly recommended broker by many of the nation's financial newsletters
and advisory services.